Smooth MBS Performance Belies Wrinkles in Kazakh Assets

It's lonely out there for Kazakh MBS 07. The only public existing asset deal from the country, it popped out mere months before the liquidity crisis made pricing untenale for originators.

The quarters that followed saw the credit squeeze abroad expose the dangers of Kazakh banks' overreliance on foreign funding. Meanwhile, an economic slowdown and shaky real estate prices at home - caused in part by a pullback in banks' own lending - put the spotlight on loans to troubled construction companies and on the shady handling of problem loans.

These issues, however, have not impaired Kazakh MBS's performance in the least. But how it has managed to stay aloof from problems can serve as only a partial lesson for others looking into existing asset deals from Kazakhstan, as some of the reasons for its success are not easily replicable.

BTA Ipoteka, a unit of Bank TuranAlem, issued Kazakh MBS in March 2007 with ABN AMRO as lead. The A-piece, amounting to $123 million, had a 22-year term and priced at 125 basis points over one-month Libor. Fitch Ratings and Moody's Investors Service rated the senior chunk 'A-' and 'A3', respectively. Two subordinated pieces added up to an additional $18.4 million, providing 15% enhancement.

Since the transaction closed, there's been a run of bad news for Kazakh banks more or less across the board. The pullback in liquidity abroad has pressured banks' margins and ratcheted down growth. Negative rating actions - or the threat of them - have followed at all three agencies.

For mortgages, one of the most jarring developments has been the sudden halt of a real estate boom, in a shift echoing what's happened in much of the U.S. A recent presentation from Fitch put the drop in prices in Almaty, the economic capital, at 35% to 40% between August 2007 and March 2008, according to both official and private sources.

Given that 50% of Kazakh MBS's pool is concentrated in Almaty, it would appear to follow that LTVs have edged up if not soared. But they are, in fact, lower than when the deal closed 16 months ago. The main reason is that the transaction assumptions were based on property prices that were current at the origination dates of the underlying loans, which were well before the boom in real estate had run its course and then reversed. "There were 13 months of seasoning on average when we ran the stat tables, one month before closing," said Tim Vieth, head of CEEMEA ABS at ABN. Prices in the beginning of 2006 were still soaring throughout the country.

In addition, the drop in real estate prices has, so far at least, been far more dramatic in Almaty than in Astana, the political capital, or in the rest of the country for that matter. The other half of the transaction's pool, therefore, hasn't seen its LTVs move all that drastically.

Another factor that has worked to strengthen the transaction - while nevertheless potentially upsetting investors who'd bargained on a longer duration - has been the exceptionally high level of prepayments. This was particularly pronounced early on in the deal. Within nine months of the transaction's closing, nearly 39% had been amortized. With credit harder to come by and banks competing less aggressively for customers in the second half of the year, prepayment rates have slipped. Still, in the most recent performance report put out by Moody's, prepayments had winnowed the senior tranche to $55 million, less than half its initial size. Enhancement for the notes is now at 25%, from 15% initially.

Delinquencies have also been negligible, but there's more to that story. Prepayments may not be behind all the loan buybacks. "They've bought back 250 loans," said Jaime Sanz, head of European emerging market securitization at Fitch. "Of those, 23 had arrears of more than 60 days, so they've taken out all the loans that were nonperforming."

This practice is not considered problematic for the transaction, as both Fitch and Moody's have re-affirmed their ratings on the deal.

An analogous practice in the broader Kazakh banking industry of restructuring and rolling over loans is considered problematic, however, as it would tend to mask problem loans. And it no doubt will be closely watched by investors in future ABS deals.

"The whole thing is really complex because of a lack of transparency," said Magar Kouyoumdjian, associate director at Standard & Poor's. The Kazakh banks report "impaired loans," which are classified in a subjective manner by management, the agency said in a recent report.

"You can never tell if a loan is really restructured and how it is accounted for," said Alexei Kechko, a director at Fitch Ratings' financial institutions group. "And different banks approach it differently."

Reported delinquency ratios, then, aren't a good indicator of asset quality at Kazakh banks. S&P uses a gauge of "loans under stress," which it says amounts to 15% to 20% of banking liabilities. The estimate is far higher than the 2% to 4% NPLs reported by the banks themselves. Loans under stress include "all overdue loans, both nonperforming and performing portions, except for technical overdues; all loans to the related parties of these problematic customers, even if they are performing; restructured loans; foreclosed or repossessed collateral currently on balance sheet; and other assets recovered in loan workouts."

S&P rates 12 Kazakh banks, which account for more than 90% of the system's assets.

Restructuring loans hasn't been an issue for the Kazakh MBS transaction, as the originator would need to take the loans on balance sheet, a practice that would be apparent. "Fundamentally, the performance of the transaction is well within our base case," Fitch's Sanz said.

The threat of government intervention in payment flows - in, for instance, a sharp devaluation - appears to be even less of an issue for the transaction. The Multilateral Investment Guarantee Agency (MIGA) provides political risk insurance (PRI) on the transaction, covering about 18 months of payment in the event of transfer, and convertibility restrictions are imposed by the government.

If anything, the Kazakh government has been a positive for the banks in general, or at least for the major ones. Cross-border investors in future ABS deals will no doubt take into account the variety of ways the government has shielded banks from a crisis. It has engaged in currency swaps with banks - which analysts said basically amount to dollar liquidity lines - in order to prop up the local currency, the tenge; it has provided credit lines for the banks to keep the beleaguered construction sector going; and via state-owned Kazakhstan Mortgage Co., the government plans to purchase mortgage loans as part of housing programs in effect from 2005 to 2007.

It can afford all this. Thanks to soaring commodity prices, the National Bank of Kazakhstan's international reserves shot to $21.23 billion as of June 20 from $17.6 billion at the end of 2007, a 20% rise.

But analysts warn that this won't solve underlying problems.

One thing is certain: tighter liquidity abroad has helped stall loan growth, an effect that analysts welcome after the unbridled lending of the last several years. Banking loans grew from KZT978 billion ($8.1 billion) at the end of 2003 to KZT7.26 trillion at the end of 2007, a rise of more than six-fold. But then the credit crunch did its work, and outstanding loans actually shrank in the first couple months of the year, subsequently resuming snail-paced growth to reach its end-of-year level in May.

Potential deleveraging on the cross-border side is an obvious way for banks to lessen their dependence on foreign funding, but it also augurs ill for future ABS issuance.

Banks have been using bilateral loans and other short-term facilities to make payments on external debt, but the share of foreign debt in total system liabilities ticked down only slightly to 51.7% in April from 54% when the turbulence began, according to S&P.

But not withstanding the problems with asset quality, the severe credit squeeze and sharp slowdown in construction activity, the economy overall still grew at 5.3% year-on-year in the first quarter, a clip that would be envied by many countries. Also, with consumer credit a relatively new thing for most Kazakhs, the level of indebtedness is far lower than in the U.S. and other Western countries.

To be sure, Kazakh RMBS is likely to remain a lone figure for the near future. But there are plans to issue more existing-asset deals further down the road. BTA Ipoteka itself is hoping to capitalize on the performance of its outstanding transaction to issue a second one at the end of this year or the beginning of 2009, said a Yerdaulet Baimukhametov, head of international relations at the bank's treasury department.

But even with positive feedback from current bondholders, he suggested that a future structure would have to be even tighter in terms of LTVs and other features. "Investors are (now) more conservative," he said.

Currently, BTA Ipoteka has a warehousing facility with ABN for $200 million.

Peer Alliance Bank is also looking into the existing asset side of things, with reports placing a consumer loan deal at between $100 million and $200 million. "We are planning to execute the transaction provided that market conditions improve," said Aigerim Yelubayeva, deputy head of capital markets at the bank. He added that the bank was only now signing the mandate letter with Merrill Lynch and Deutsche Bank.